The recent volatility warned of a big move coming and the likely move was to be down. Today's decline did some technical damage as support levels snapped like little twigs, but the bulls can't be discounted yet.

Wednesday's Market Stats

Following a period of very low volatility in price movements we started to get much greater price swings in the past week and that's usually a sign of instability. At market lows we usually find v-bottom reversals but at tops there's more of a battle and that battle shows up in more violent price swings. For this reason it's usually a good sign that a more serious decline is right around the corner. It doesn't tell you how long the decline will last but it's at least a short-term warning.

We now have a stronger decline and many are wondering if this is the start of the "big" one. It's too early to tell but the break of solid support levels certainly has raised the fear level (and put buying). The VIX is shooting back up and short-term we could have a setup for at least a bounce. Only by watching what kind of bounce we get (if we get one) will we then get a better idea for what might follow. As I'll get into with the charts, there are some interesting patterns that point both ways, which doesn't help us in the short term but the evidence from the price action in the coming days should give us some very good clues to tie in with what I'm seeing currently.

Today's economic reports started off with the ADP Employment change before the market opened, which was slightly better than expected for September and slightly better than the August number. Equity futures got a little bounce out of the report but it was short-lived as the sellers hit the tape as soon as the opening bell rang. With very little geopolitical or economic news to discuss I'm just going to jump into the chart review.

I'll start tonight's review with the RUT since it's at an interesting level with today's decline. Since first reaching 1080 in September 2013 that level has acted as support -- in November 2013 and then in February and May this year (near 1082.50). It's now back down for another test with this afternoon's low at 1083 and if I were bullish the stock market I could make the argument that we're seeing the completion of a 3-wave pullback from July, which is setting up the next rally. A strike against the bulls here is the fact that the test of 1980-1983 is not showing bullish divergence, as noted on the weekly chart below, which I would expect to see if a new rally leg was setting up. The bearish wave count says the July high has been followed by a 1st and 2nd wave and we're into the 3rd wave down. I show a bearish wave count (in bold red) down to the 200-week MA by December, perhaps near 930 by then, and then a strong bounce back up into the new year before the larger 3rd wave down sets up in the first quarter.

Russell-2000, RUT, Weekly chart

As for the bullish potential for just an a-b-c pullback from July, the leg down from September 3rd would be the c-wave (instead of the start of the 3rd wave). The start of the decline from September 3rd is ugly (corrective) but I could argue the move down from that high completed its 5th wave today (or will consolidate for a few days before making a 5th wave low). One thing supporting the a-b-c pullback idea, if the RUT is able to hold above 1077, is the fact that two equal legs down points to 1077.61, which is very close to the price-level support near 1080. This projection crosses the bottom of a parallel down-channel from July tomorrow, which can be seen on the daily chart below, and with the daily oscillators oversold it's not hard to see this as a bullish setup.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1164
- bearish below 1077

If the 3-wave pullback from July is a bullish pattern we're now close to starting a large rally into the end of the year. If it's a bearish pattern we'll get a relatively high bounce in the next couple of weeks to complete another smaller-degree 2nd wave correction (shown in red on the above chart) before starting a more serious decline. The other indexes do not match the bearish pattern but they do support the potential for at least a high bounce, if not the start of a major rally, so bears need to be cautious here.

There's an interesting fractal pattern that deserves the attention of bears as well (as a warning sign here). As can be seen on the S&P e-mini futures (ES) daily chart below, since the December 2013 high we've had 4 times where the high was exceeded with a minor new high with bearish divergence (lower highs on RSI). Each of those cases led to a break of the 50-dma and a test of the uptrend line from November 2012 - February 2014 (obviously the first instance, with the February low, created the uptrend line). The test of the uptrend line then led to the start of the next rally back above the 50-dma and to a new high. Will we get another rally out of this setup?

S&P 500 e-mini futures, ES, Daily chart

The fractal pattern noted above suggests we should buy support here for another rally into the end of the year. The bearish pattern is a 3-drives-to-a-high following the initial December-January high, which is a setup for a major reversal. The test is on here -- the bulls want support to hold and a strong rally to follow. If we get several days with white candles, like the previous 3 times, get ready for new highs. But if we get a bounce followed by new lows, get ready to rumble to the downside.

On the daily SPX chart below you can see the same fractal pattern at the July and September highs as noted on the ES chart. Not shown on the chart are the Fib projections for the 2nd leg of the pullbacks from the initial highs (wave-c of an expanded flat correction off the initial high). Following the July highs the c-wave was 262% of the a-wave. The same projection for the leg down from September 19th points to 1934 so a decline below that level would be further proof that this time it's different but until then we have to consider the bullish potential here. Obviously what's bearish today is the break of the uptrend line from November 2012 - February 2014, near 1953. But a 1-day break could easily be a head-fake break.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 2000
- bearish below 1950

The 60-min chart below shows some idea for what might follow, all of which assume today's low (or a minor new low Thursday morning) will hold for at least a few days. The very bearish wave count (nested 1st and 2nd waves, shown with the light red dashed line) calls for a relatively sharp bounce back up to perhaps price-level resistance near 1966, completing by Thursday afternoon, and then a very sharp and strong selloff to follow (to unwind a series of 3rd waves). The next bearish count (bold red) says we'll get a choppy sideways correction that could stay below the broken uptrend line from November 2012 and then another leg down to complete a 5-wave move down from September 24th (to complete wave-3). The bullish pattern (green wave count) would look best with a bounce and then another new low before setting up the end-of-year rally but that one's a challenge because of the corrective wave count. Each suggests a bounce from here and then lower before potentially setting up something more bullish but it will be the bounce pattern (assuming we'll get the bounce) that will provide more clues about what should follow.

S&P 500, SPX, 60-min chart

The DOW fought to hold price-level support and its 50-dma, at about 16930-16950, since first testing it on September 25th. That support level snapped quickly this morning and there was no real effort to bounce back above it. A minor bounce off this morning's low gave us a back-test of the 50-dma but that was followed by a bearish kiss goodbye or another 150-point drop. Not a good day for the bulls but the bears are feeling pretty good. Other than the break of its uptrend line from October 2011 - November 2012 (log scale whereas using the arithmetic scale the uptrend line from November 2012 - February 2014 is near the same level), the other bearish thing I see on the daily chart below is MACD has now dropped below zero. For a few days I was wondering if support would hold and MACD turn back up from the zero line, which would have given us a buy signal. Hasn't happened.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 15,860
- bearish below 15,530

Resistance to a bounce for the DOW is now the broken uptrend line (lines, depending on scale used) and price-level S/R at 16930-16950. Watch for a back-test/bearish kiss goodbye if tested. I show how a 5-wave move down might play out this month for a drop down to price-level support near 16330. This is obviously speculation at this time but I wanted to show downside potential for those sitting in bullish October options positions. The bearish wave count is in a position where bounces from here to there could be only small ones.

Not shown on the daily chart is the longer-term trend line along the highs from 2000-2007, which is near 16835. Both support lines were broken into the August lows, by a wide margin, and yet the index came roaring back and went on to new highs anyway. Whether that will happen again is anyone's guess but usually a 2nd break of support is the real deal (the 2nd mouse gets the cheese).

Patient and prepared mouse:

NDX broke price-level support near 4050 and its uptrend line from April-August on September 25th but held above its 50-dma near 4015 for four days before breaking it today. On the bounce back up it back-tested the price-level S/R, its broken uptrend line and its broken 20-dma (yesterday) and then left a bearish kiss goodbye with today's selloff. It stays bearish below 4010 and it won't turn bullish until it gets back above Tuesday's high at 4070.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 4070
- bearish below 4010

Keep an eye on the semiconductor index here. We know it has a large influence on the tech indexes but it's also an important barometer for how traders are feeling about the market in general since it's a very good indicator for the health of the economy. Many weeks ago I had pointed out a price target for the SOX at 656.57, which was based on an A-B-C bounce pattern off its November 2008 low where the two rally legs (wave-A and wave-C) would be equal. The July high was near 652 (not quite there) and the September high was near 659, which rang the bell. The bounce correction off the 2008 low can be considered complete at any time but better proof would first come with a break below 620 -- it would get back below the 38% retracement of the 2000-2002 decline, near 624 (you did realize that's all the bounce amounted to, right?), and its uptrend line from November 2012, which would help identify the conclusion to the c-wave. So watch carefully what it does since it's still inside its up-channel and therefore still potentially bullish.

Semiconductor index, SOX, weekly chart

A few weeks ago I thought bond yields were ready for a rally to correct the decline from January into the August low. We got a strong bounce into the September 17th high but bonds rallied again and yields have dropped back down toward their August lows. The setup looks good for another leg up to complete a larger a-b-c bounce correction, as shown on the TYX weekly chart below, before heading lower into next year. If TYX instead drops from here and makes it down to the bottom of its down-channel from January, currently near 2.92%, it would create a setup for a much higher rally in yields but as long as a test of the low, or even a minor new low, is with bullish divergence I'll be looking for a relatively quick bounce into early November before we'll get a stronger decline in bond yields (flight to safety as the market does the real work without the Fed's "help").

30-year Yield, TYX, Weekly chart

Last week I showed the weekly chart of TRAN to point out the setup for a top of significance. It has wedged itself up into the top of a rising wedge for price action since 2010 and had achieved a price projection at 8591 for an a-b-c move up from October 2011 (the c-wave is 262% of the a-wave). Today it got slammed to the downside right out of the gate this morning (I haven't taken the time to find the guilty stock that caused the selloff in the sector) and it broke its uptrend line from June 2013 - February 2014, near 8334. It had been holding up at its 50-dma, near 8390, but that was one of the support levels that were snapped like little twigs this morning. The move down from Tuesday looks like completed 5-wave move and we should therefore get a bounce on Thursday but watch for a back-test of support-turned-resistance. It takes a rally back above 8400 to tell the bears to back off.

Transportation Index, TRAN, Daily chart

The screaming eagle, otherwise known as the U.S. dollar, is showing no signs yet of letting up on its rally. While each white candle on the weekly chart below is not that large, this has been a very long streak of steady weekly gains since July, the longest since March 1967 according to Bloomberg It is poking above the trend line along the highs from July 2012 - July 2013, near 85.91, and if it holds above it we'll likely see a rally up to the downtrend line from March 2009 - June 2010, currently near 86.90. This puppy is due for a rest.

U.S. Dollar contract, DX, Weekly chart

The screaming dollar has had the opposite effect on commodities, including the metals, although gold hasn't reacted as negatively as one might expect. A lot of the strength in the dollar has to do with relative value. All countries are in a race for the bottom as each takes care of its own needs and each is attempting to devalue their currency to make their own goods more competitively priced in the global market. But the U.S. is currently one of the best of the weak with a fairly stable economy and very little social strife. The U.S. is safe.

Gold's price is negatively affected by the rising dollar but it's more or less an emotional metal (other than hard needs for jewelry and electronics) and those who fear inflation (with the debasement of fiat currencies) buy gold. The trouble for gold is that more and more investors are starting to talk seriously about deflation, which is bad for things like gold (and most other asset classes). Silver, because of it industrial value as well as currency value, has really taken it on the chin but gold still has a chance for a relatively large bounce before heading lower.

As I've been showing for gold, and there's been very little change in the past week, two equal legs down from March is at 1194.40, which coincides with the bottom of a potential sideways triangle off June 2013 low. If it drops below 1194 there will be immediate downside risk for gold bulls. But I continue to see the potential for a rally up to about 1325 this year before heading lower next year.

Gold continuous contract, GC, Weekly chart

Silver has already broken down from its equivalent sideways triangle (a descending triangle with a flatter bottom) and has downside potential to 12.18 (height of triangle, projected from the bottom of the triangle) and certainly to price-level support near 14.65. But it could be due for a bounce now that it has tagged, and held, its uptrend line from 2003-2008 with Tuesday's low at 16.85. The bottom of the triangle, near 18.60, should now be resistance if back-tested.

Silver continuous contract, SI, Weekly chart

Oil has been chopping sideways for the past few weeks, which has it looking like it could drop at least a little further before attempting a bounce. Two equal legs down from August points to 86.73, close to an uptrend line form October 2011 - June 2012, which could be the bottom of a bullish sideways triangle off the May 2011 high. But I think oil's picture is bearish and until proven otherwise I'm thinking bounces are to be sold.

Oil continuous contract, CL, Weekly chart

Thursday's economic report include Factory Orders after the opening bell and the report is expected to show a sharp reversal off July's +10.5% into a -9.3%. If it's not worse than that it might be enough to spark a relief rally.

Economic reports and Summary

One more chart to highlight the reason I think bears need to be careful since we have another reason for the dipsters to ply their trade here. Since June 2012 each time the VIX has hit its 200-week MA it has pulled right back down, with a rally in the stock market of course. You can see on the VIX weekly chart below it has happened 7 times since June 2012, this being the 7th time. Whether this will result in the same kind of pullback, with a new market high to follow, or if instead it will be different this time, we'll only know the answer in hindsight. But just as the fractal pattern that I showed on the ES and SPX charts point to the potential for a new rally, so too does the VIX chart. Bears need to watch carefully and don't get complacent thinking "this is finally it!"

Volatility index, VIX, Weekly chart

There are several technical pieces in place to strongly suggest an important top is in place, and there's significant downside risk (hear that bulls?) as market crashes come out of oversold and we've had the requisite warnings from things like the Hindenburg Omen (last week). But the fat lady hasn't sung her song yet and therefore both sides need to exercise caution here. In the past week especially, each day the next higher-probability move has changed and the market could flip the bears on their heads again now that many longs have been stopped out of their positions. Important support levels were broken today but 1-day breaks don't count. It's better for the bears if we see 2-day and 3-day breaks to confirm it's real, which would be especially helped with back-tests followed by bearish kiss goodbyes.

There was heavy put buying today as investors started to fear what kind of pullback we'll get. The market is on the edge here and could easily fall off, leading to a much stronger decline than most market participants are expecting. But the price pattern still supports the idea that we've had just another pullback that will lead to the start of yet another rally, one that will take us to new highs in November-December. Keep trades short-term, take profits (losses) early and quickly while we wait for the larger direction to identify itself. The bull-bear battle is heating up. Trade safe.

Good luck and I'll be back with you next Wednesday.

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying